Do ESG companies in Saudi Arabia outperform market risk factors Empirical Evidence from the Tadawul Exchange

Abstract

Environmental, Social and Governance (ESG) is an approach aimed at increasing sustainability and promoting ethical and responsible practices. Although it is yet to be mandatory in Saudi Arabia and is still in its early stages, this has resulted in ignorance of ESG, as the benefit remains unclear. A 2021 Murad Ali did a study on ESG reporting in Saudi Arabia and found that there is a significant gap in ESG reporting in Saudi Arabia, indicating that ESG in Saudi Arabia may not be mature enough to be considered. Additionally, a 2020 research paper by Hussein Mohammad Salameh that used the 5-factor model, 3-factor model and CAPM concluded that due to the nature of the Tadawul exchange being different to the rest of the world due to Islamic Sharia and laws, it is challenging to find accurate results. This research paper aims to run a linear regression using the Carhart Four Factor Model to five portfolios that consist of the top 50 ESG firms in the Saudi Arabia Stock Exchange (Tadawul) to uncover if firms more aligned with ESG are outperforming market risk factors.  Empirically, the results show that the top 20 ESG firms in Saudi Arabia outperform market risk factors on a consistent basis; more specifically, the p-value rejects the null hypothesis, which indicates ESG outperforming regular stocks on a risk-adjusted basis, with the rest accepting the null hypothesis. The results suggest that while ESG is still a new topic in the business world, firms that are implementing it may benefit in the Tadawul Exchange. It is worth noting that the majority of the firms in the highest-rated portfolio were banks and telecom firms, which could invalidate the result. Further research is necessary to conclude the impact of ESG on returns.